Shu Yi Oei: The Offshore Tax Enforcement Dragnet

Shu Yi Oei (Tulane) has posted an important new paper on U.S. offshore tax enforcement, of interest. Here is the abstract:

Taxpayers who hide assets abroad to evade taxes present a serious enforcement challenge for the United States. In response, the U.S. has developed a family of initiatives that punish and rehabilitate non-compliant taxpayers, raise revenues, and require widespread reporting of offshore financial information. Yet, while these initiatives help catch willful tax cheats, they have also adversely affected immigrants, Americans living abroad, and “accidental Americans.”  

This Article critiques the United States’ offshore tax enforcement initiatives, arguing that the U.S. has prioritized two problematic policy commitments in designing enforcement at the expense of competing considerations: First, the U.S. has attempted to equalize enforcement against taxpayers with solely domestic holdings and those with harder-to-detect offshore holdings by imposing harsher reporting requirements and penalties on the latter. But in doing so, it has failed to appropriately distinguish among differently situated taxpayers with offshore holdings. Second, the U.S. has focused on revenue and enforcement, ignoring the significant compliance costs and social harms that its initiatives create.  

The confluence of these two policy commitments risks creating high costs for the wrong taxpayers. While offshore tax enforcement may have been designed to catch high¬-net-worth tax cheats, it may instead impose disproportionate burdens on those immigrants and expatriates who have less ability to complain, comply, or “substitute out” of the law’s grasp. This Article argues that the U.S. should redesign its enforcement approach to minimize these risks and suggests reforms to this end.

The paper provides a thorough review of the panoply of offshore enforcement programs and mechanisms and documents the harms of their dragnet approach, especially on the most vulnerable and least likely targets. A significant contribution to the literature.

Updated: Gotcha! Yet another obscure asset reporting form for US persons

UPDATE: as of sometime this afternoon (depending on your time zone), the BEA has updated its website to extend the filing deadline to June 30 for all new filers. Moreover, it appears that the BEA definition of US Persons is generally limited to persons resident in the United States (with specific exceptions, see comment from Andrew below). As I mention in the comments, I am a bit wary about drawing conclusions of law from instructions to forms but I do think that the instructions at least form the basis for reliance that most physically non-resident US citizens should not be required to fill out the BE-10.  The sudden deadline extension nevertheless suggests that a number of people have been caught by surprise by the new reporting obligation, so that my main point about educating one's regulatory target is still apposite. I have revised this post accordingly.

It seems that in the United States, the asset reporting forms and non-filing penalties just keep on coming, and yet the will to inform individuals about their obligations--especially those who live outside of the United States and do not receive client alerts from big US law firms or big 4 accounting firms--remains curiously absent.  The Bureau of Economic Analysis does a survey of "US Direct Investment Abroad" every five years. In past years, if you were required to file, the BEA contacted you.

Not any more; now you are just supposed to know that the BEA exists and has its own reporting requirements, and that if you are a US person (which includes individuals), you are supposed to go and file a report to them, separate and distinct from all of of your other tax and financial asset reporting requirements. I do not know what the definition of US Person is for BEA purposes, and whether it includes US citizens and other persons, regardless of their residence--looking into that now. The definition of US Person for BEA purposes appears to diverge from that for tax purposes, such that in most cases reporting is required by those physically resident in the United States.

BEA reporting is subject to a civil penalty of $2,500 to $25,000 for nonfiling, plus $10,000, or a year in jail, or both, if the nonfiling was wilful. I am not sure who is responsible for collecting this fine but if it is the IRS (as is the case for FBAR), then I wonder why the Service doesn't bother to tell taxpayers about the form and its deadline anywhere at all on the IRS website.

A BE-10 form must be filed by any US Person that directly or indirectly held 10% or more of the voting securities ("US Reporter") of any non-U.S. business enterprise (a “Foreign Affiliate”). There are no de minimis exceptions: no matter how small your nonUS corporation might be (or have been-you must file for the year even if the corporation ceases to exist), you must report or face the penalty. US Reporters must file Form BE-10A for themselves and may have to file additional BE-10 forms for their corporations.

The deadline is tomorrow: May 29 now June 30. There is an extension available but it requires filing a request prior to the due date. Prepare for a delay in accessing that form right now--the BEA server appears to be overloaded. Possibly a request to extend filed today (if that is even possible from outside the United States) would be granted, I am not sure.

The BEA is a valuable source of information necessary for policy research, and I do not in any way object to the general need to collect information on US companies. What I object to is that again and again, US regulators seems to forget that "US Persons" includes a massive population of individuals who live permanently outside of the territory, who cannot realistically be expected to simply "know" about all the forms they are supposed to report, and who are dramatically underserved by the US agencies that continue to produce these requirements. US Persons are now potentially subject to three overlapping and duplicative reporting regimes, each with its own quirky forms, convoluted instructions, inconsistent deadlines, and heavy penalties: the IRS, the Financial Crimes Enforcement Network, and now, every five years, the BEA, all with little to no effort to educate the population each agency expects to be fully compliant.

I do wish that US lawmakers would understand that when they enact complex regulatory regimes with hefty penalties, they have a responsibility to educate the targets of that regulation. I am not talking about large, multinational conglomerates or high net worth individuals with teams of legal counsel. They are protected: their counsel's job is to keep up to date on all regulatory compliance regimes, inform their clientele, and and make money off compliance fees. I am not worried about them. I am talking about the human beings who just happen to live and work in other countries. If they have small businesses, they may well have non-US corporations in those countries where they live and work.  Regulatory agencies that seek to regulate these individuals have a responsibility to inform that is global in scope. It seems to me obviously unjust to suddenly impose complex requirements, with attendant penalties, on a whole new population without making any effort to educate them that this is the new order of things. Today's last-minute deadline extension seems to acknowledge this basic issue.

On Paperwork and Punishment: It's Time to Fix FBAR

I published this last month but neglected to post it: my latest column in Tax Notes International takes a look at the foreign bank account report, or FBAR. Feel free to download it, early and often, right here. Here is the abstract:

The Foreign Bank Account Report, or FBAR, is part of a regime designed to stop terrorists, money-launderers, and tax evaders. Unfortunately, its increasingly draconian requirements and consequences now apply to millions of innocent bystanders who are collateral damage in the ongoing battle against financial crime. Their inclusion in the FBAR regime is a massive waste of both government and taxpayer resources, effectively criminalizing activities that are wholly unconnected to financial crime, and perversely discouraging compliance. All of this is unnecessary because as the administrator of FBAR, Treasury can immediately fix the problems. The difficulty is that FBAR is still relatively obscure to those not caught in its grasp, and the extent of the damage it is doing to U.S. taxpayers and to the integrity of the tax system is thus under-appreciated. This damage is real, but it can be reversed by re-focusing FBAR where Congress intended: on likely criminal activity. In short, this Essay demonstrates that the FBAR regime is broken and it is time for Treasury to fix it.

As always, I welcome comments.

FBAR e-filing: violates Taxpayer Bill of Rights, challengeable under Haar

Eric Kroh of Tax Analysts has a story today [gated] on the basic nonsense that is the FBAR (foreign bank account report) e-filing system. As he reports, in defiance of common sense, FinCEN's system does not work for normal users. It does not work on a mac at all, and it does not work on a PC if you have Adobe Acrobat installed (the user must uninstall and use adobe reader instead). So now in addition to frightening people by forcing them to register themselves for monitoring by "Financial Crimes Enforcement," making them feel like criminals just by visiting the website, the US Treasury is all about making sure the user encounters error after error, frustration without end, with no alternative because e-filing is required.

I'll make two points here. First, I think the entire FinCN experience violates the Taxpayer Bill of Rights recently adopted by the IRS, and second, I think the e-filing requirement is susceptible to legal challenge under the recent decision of the Massachusetts Appellate Tax Board in Haar v Commr. Let's look at the TBOR first.

Kroh's article demonstrates that FinCEN's FBAR system pretty clearly violates provision 2 of the Taxpayer Bill of Rights, which guarantees taxpayers a right to quality service. Kroh describes how ridiculous it is to have a form-filing system that conflicts with one of the most ubiquitous pieces of software out there, namely, Adobe Acrobat. He notes that the FinCEN website fails to explain the known issues and offers no promises about maybe fixing this very basic problem. IRS: no blaming things on FinCEN to get out of your obligations. You're administering this mess. (FinCEN is a bureau of Treasury separate from the IRS, but IRS has responsibility for enforcing FBAR by levying penalties for non-compliance.)

The FinCEN experience also violates provision 10 in my view. Provision 10 says taxpayers have the "right to a fair and just tax system." It is neither fair or just in my view to force individuals to register and transmit sensitive personal information on a website that is built for the sole purpose of detecting money laundering, terrorist financing, and other financial crimes, where no evidence exists that the individuals have perpetuated or are planning to perpetuate any such crimes. This process constitutes an intimidation tactic. If you don't believe it, I invite you to visit the FinCEN website, register yourself, and file an FBAR form as a civics lesson.

I am not saying Treasury doesn't need the information FBAR requires (though much or most of it is egregiously duplicative with IRS forms that non-resident US persons already have to file). But I am saying there is no way that Treasury needs to extract this information by making individuals register on a website that so clearly transmits the message: "you are a suspected criminal and we are watching you."

Remember, we are talking about millions and millions of people who have "foreign" bank accounts because they live in foreign countries; most are citizens of those foreign countries where they live; and their banks are local to them. Congress treats these people as if they live in the United States, when they do not. But Congress does not similarly treat their local bank accounts as local (Congress should do so, and would fix many problems if they did, as I argued in a Tax Analysts column in 2012). This mismatch of fiction against fact does not make people money launderers or tax evaders. Many, many of these individuals are unjustly caught up in the US tax net because of the madness of citizenship taxation. Also: consider that the FBAR instructions even say that kids ought to fill out their own FBAR forms. Come on.

Taxpayer Rights, yes. But remedies? Not so Clear.

Whether violating the taxpayer bill of rights creates grounds for a lawsuit remains to be seen; I think Congress' continuous failure to codify the TBOR is precisely to prevent this possibility (I discussed the issue here). But the recent case of Haar v Commissioner suggests that a lawsuit challenging the requirement that FBAR forms be filed electronically would have merit. I note from Kroh's article:

According to a FinCEN FAQ, failure to comply with the electronic filing mandate could result in civil penalties, including a $500 fine for each negligent currency transaction. Exceptions to the mandate are allowed only in some limited circumstances, according to the agency. 

Now comes Haar:

This appeal involves the Commissioner’s assessment of a $100 penalty... because of the appellant’s failure to electronically submit [a payment in connection with an extension of time to file]...

 Mr. Haar maintained that the Commissioner’s electronic payment mandate is a “serious invasion of both [his] privacy and [his] personal business practices,” as it exposes his finances to risk of cyber attack.  On his abatement application, Mr. Haar explained, “I intentionally do no electronic banking nor direct bill paying, I have none of my credit cards linked to my bank accounts directly and I think anyone who does any of the above is exposing themselves to multiple risks of cybercrime and identity theft.”  At the hearing, Mr. Haar testified that he does not link his “bank account information in any electronic way to any other electronic medium” because he believes it is a “very foolish thing to do.” Mr. Haar further expressed doubts as to the security of the computer systems used by the Department of Revenue (“DOR”), noting that “if the Pentagon can be hacked,” he had little confidence that DOR could protect his – or any other taxpayer’s – personal data from theft. 

To which the Commissioner responded:

It was the Commissioner’s position ... that... she has the authority to mandate electronic filing and payment and to assess penalties if, after notice, a taxpayer failed to comply with the prescribed filing and payment mandates.  While ... penalties may be abated if a taxpayer can demonstrate “reasonable cause” for non-compliance, the Commissioner maintained that the appellant did not establish reasonable cause because Administrative Procedure 633 (“AP 633”) provides that “[t]he fact that a taxpayer does not own a computer or is uncomfortable with electronic data or funds transfer will not support a claim for reasonable cause.”  AP 633(II)(D). 

But the Appellate Tax Board saw things differently, noting that Treasury has steadily expanded e-filing requirements, but that there is no federal requirement that individual e-file their annual tax returns, and that reasonable cause is an objective standard that can't be eliminated by a mere declaration by Administrative Procedure. The ATB concluded:

On the facts of this appeal, particularly the appellant’s credible testimony concerning his consistent practice of avoiding the payment of his bills electronically, the Board found and ruled that the appellant exercised the degree of care that an ordinary taxpayer in his position would have exercised when he made his timely payment by check, contrary to the Commissioner’s electronic payment mandate.  The Board therefore found and ruled that the appellant met his burden of proving reasonable cause under § 33(g) for his failure to remit payment electronically in connection with his extension application for the tax year at issue. 

Accordingly, the Board issued a decision for the appellant in this appeal and granted an abatement of the $100 penalty, along with statutory additions. 

I note that Haar represented himself in that appeal. When I saw that FinCEN had made e-filing mandatory, I wondered if it would spark lawsuits. The Haar case suggests that such lawsuits might prevail if the facts and legal standards align.

Lawsuits are not the only way to protect taxpayer rights in this case, however. If the US practiced residence based taxation like the rest of the world, the universe of US taxpayers who have foreign bank accounts but who aren't rich enough to employ others to deal with complex US filing obligations will shrink to a negligible number and the issue all but goes away. Until then, Treasury can act, and act quickly to resolve the technical problems here, even if we have to wait for Congress to fix the underlying defect of citizenship taxation.

The solution is clear: Treasury should abolish FinCEN registration for FBAR purposes alone and the FBAR should be treated like other tax forms since it is administered by the IRS. The IRS should make the FBAR form available as a regular pdf on the IRS website like all the other tax forms, and have a link so people who choose to e-file can do so.